Involuntary Bankruptcy Petitions: Factors for Debtors and Creditors to Consider

The following factors should be carefully analyzed with bankruptcy counsel when considering the risks of an involuntary bankruptcy petition under Section 303 of the Bankruptcy Code:

1) If the proposed debtor has fewer than 12 creditors, it only takes one qualifying creditor to file an involuntary petition. What this means is that IT IS BETTER IF THERE ARE AT LEAST 13 REAL CREDITORS.

However, occasionally a single creditor files the involuntary case and it turns out that the company has MORE than 12 creditors. It’s not a fatal error, but it would be a DEFENSE to the filing of the involuntary bankruptcy petition.

2) If the proposed debtor has 12 or more creditors, an involuntary bankruptcy petition requires (a) three or more creditors whose claims are not contingent as to liability or subject to a bona fide dispute as to either liability or amount to file the petition, and (b) those qualifying claims must total, in the aggregate, at least $14,425 if unsecured or $14,425 more than the value of any liens securing those claims if any are secured. The $14,425 figure is scheduled for adjustment in April, 2013.

3) An involuntary petition is like a lawsuit, procedurally. The petitioning creditor(s) will file a bare bones bankruptcy, choose Chapter 7 (liquidation) or Chapter 11 (reorganization), and the

Bankruptcy Court will issue a summons against the proposed debtor. The proposed debtor then has 21 days in which to file a response. If it doesn’t, the proposed debtor will be “in bankruptcy” by default.

4) To contest an involuntary petition, the proposed debtor must do so within the time allotted by the Federal Rules of Bankruptcy Procedure, currently 21 days after service of the summons. Typically that involves filing an answer or a motion to dismiss. The motion to dismiss route is what the debtor would file if the creditor ignored the three-creditor filing requirement.

5) If the proposed debtor timely objects (answers) to the involuntary filing, there is a short discovery window and a hearing is usually scheduled within 45 days of the filing of the answer. The issues for consideration at the initial hearing are as follows:

A) a proposed debtor must generally not be paying its debts as they become due unless those debts are subject to a bona fide dispute as to liability or amount;

Or

(B) a proposed debtor must not have had a custodian appointed within the past 120 days to take possession or control of substantially all of its assets.

(6) The automatic stay protecting a proposed debtor against collection efforts kicks in immediately upon the filing of the involuntary petition, but NO TRUSTEE is automatically appointed until the hearing on the adequacy of the involuntary petition, and the debtor continues to operate its business as normal. This window clearly does not benefit creditors because the debtor has advance warning of what’s coming and often takes steps to minimize damage, all the while being protected from collection efforts, even by the petitioning creditor. If a creditor had issued writs of garnishment which were producing a payment stream, the filing of the involuntary petition against the individual being garnisheed would automatically stop that collection process.

(7) If the bankruptcy court ultimately rules in favor of the petitioning creditors, an “order for relief” is entered and the company is officially placed into bankruptcy. At that point, the company is subject to the Bankruptcy Code’s provisions and supervision by the bankruptcy court, INCLUDING THE APPOINTMENT OF A TRUSTEE.

(8) Partnerships do have a FEW minor differences in the requirements for filing an involuntary case, but unless the partnership is the party against whom the bank may file the involuntary petition, this issue won’t be discussed here. Retain competent bankruptcy counsel to determine your rights.

Factors for a Creditor to consider relative to involuntary petitions:

Once filed, an involuntary petition cannot be dismissed without a notice and an opportunity for a hearing, even if the petitioning creditors and the company agree. If the involuntary petition is dismissed, the petitioning creditors can be liable for costs and attorney’s fees of the debtor entity. If the bankruptcy court determines that the involuntary petition was filed in bad faith, the petitioning creditors can be held liable as well for damages caused by the involuntary filing and even for punitive damages. This could be a MAJOR disincentive with regard to a filing of an involuntary petition against any debtor entities.

Because of the risks to the filing creditor, the involuntary bankruptcy route is not a routinely utilized remedy. The prospect of creditor liability for costs, attorney’s fees, damages, and possibly punitive damages makes involuntary petitions one of the lesser-used creditor tools. Involuntary bankruptcy is most often used when unsecured creditors suspect fraud on the part of a debtor company, such as when a Ponzi scheme is discovered, or for some other extraordinary reason. Otherwise, creditors will typically pursue collection of their own claims directly, including through litigation in state or federal court. That might end up “forcing” the debtor company into voluntary bankruptcy, but it would be a bankruptcy of the voluntary kind.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on litigation and dispute resolution, including representing clients in all forms of alternative dispute resolution and serving as mediators in private dispute resolutions for third parties.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.

About the Authors: The law firm of Albright, Stoddard, Warnick & Albright is an A-V Rated Nevada-based full-service law firm having attorneys licensed in Nevada, California and Utah. Our firm’s practice includes a strong emphasis on personal injury accidents. Call us at 702-384-7111.

Note: This article, and any other information you obtain at this website, is not offered as legal advice, nor should it be relied upon as such, nor is it a solicitation for legal services. Only a licensed attorney can advise you with respect to your specific legal needs. We welcome your contacting our firm to discuss such representation. Contacting us does not create an attorney-client relationship. Please do not send any confidential information to us until such time as an attorney-client relationship has been established.